Eurocurrency Market Characteristics
Eurocurrency Market Characteristics
The Eurocurrency market has several interesting characteristics:
1. It is a wholesale rather than retail market, which means that transactions tend to be very large. Public borrowers such as governments, central banks, and public-sector corporations tend to borrow most of the funds. Also, nearly four fifths of the Eurodollar market is interbank, which means that the transactions take place between banks.
2. The market is essentially unregulated.
3. Deposits are primarily short term. Most of the deposits are interbank, and they tend to be very short term. This leads to concern about risk, since most Eurocurrency loans are for longer periods of time. _
4. The Eurocurrency market exists for savings and time deposits rather than demand deposits. That is, institutions that create Eurodollar deposits do not draw down those deposits into a particular national currency in order to buy goods and services.
5. The Eurocurrency market is primarily a Eurodollar market (see Fig. 9.2).
In addition to ordinary deposits in the Eurocurrency market, there are
also certificates of deposit (CDs) available in dollars, sterling, and yen. Al-
though CjDs_^re_availaJ2le_irij^ most are traded in multiples
of $1 million or more. The CDs are usually quoted at a discount at a fixed
interest rate, but they can also be quoted at floating interest rates.
The Eurocurrency market has short- and medium-term characteristics. Short-term Eurocurrency borrowing has a maturity of less than one year. However, it is also possible to borrow at maturities exceeding one year. Anything over one year is considered a Eurocredit. These Eurocredits may be loans, lines of credit, or other forfns of medium- and long-term credits, in-cluding syndication, in which several banks pool resources to extend credit to a borrower.,
A major attraction of the Eurocurrency market is the difference in interest rates as compared with domestic markets. Because of the large transactions and the lack of controls and their attendant costs, Eurocurrency deposits tend to yield more than domestic deposits, and loans tend to be relatively cheaper than in domestic markets. Figure 9.3 illustrates these differences in interest rates. Traditionally, loans are made at a certain percentage above the London Inter-Bank Offered Rate (LIBOR), which is the interest rate banks charge one another on loans of Eurocurrencies. The interest rate above LIBOR, which is characterized in Fig. 9.3 as the Eurocurrency borrowing rate, depends on the credit-worthiness of the customer and must be large enough to cover expenses and build reserves against possible losses. The unique characteristics of the Eurocurrency market allow the borrowing rate usually to be less than it would be in the domestic market. Most loans are made on variable-rate terms, and the rate-fixing period is generally six months, although it could also be one or three months. Because of the variable nature of the interest rates, the maturities can extend into the future.
The LIBID is the bid rate that corresponds to the LIBOR, and the difference between the LIBOR and the LIBID is usually about one eighth of a per-centage point. The rate one earns on deposits in the Eurocurrency is usually less than the LIBID, but it is often more than can be earned in the domestic market.
The Eurocurrency market has several interesting characteristics:
1. It is a wholesale rather than retail market, which means that transactions tend to be very large. Public borrowers such as governments, central banks, and public-sector corporations tend to borrow most of the funds. Also, nearly four fifths of the Eurodollar market is interbank, which means that the transactions take place between banks.
2. The market is essentially unregulated.
3. Deposits are primarily short term. Most of the deposits are interbank, and they tend to be very short term. This leads to concern about risk, since most Eurocurrency loans are for longer periods of time. _
4. The Eurocurrency market exists for savings and time deposits rather than demand deposits. That is, institutions that create Eurodollar deposits do not draw down those deposits into a particular national currency in order to buy goods and services.
5. The Eurocurrency market is primarily a Eurodollar market (see Fig. 9.2).
In addition to ordinary deposits in the Eurocurrency market, there are
also certificates of deposit (CDs) available in dollars, sterling, and yen. Al-
though CjDs_^re_availaJ2le_irij^ most are traded in multiples
of $1 million or more. The CDs are usually quoted at a discount at a fixed
interest rate, but they can also be quoted at floating interest rates.
The Eurocurrency market has short- and medium-term characteristics. Short-term Eurocurrency borrowing has a maturity of less than one year. However, it is also possible to borrow at maturities exceeding one year. Anything over one year is considered a Eurocredit. These Eurocredits may be loans, lines of credit, or other forfns of medium- and long-term credits, in-cluding syndication, in which several banks pool resources to extend credit to a borrower.,
A major attraction of the Eurocurrency market is the difference in interest rates as compared with domestic markets. Because of the large transactions and the lack of controls and their attendant costs, Eurocurrency deposits tend to yield more than domestic deposits, and loans tend to be relatively cheaper than in domestic markets. Figure 9.3 illustrates these differences in interest rates. Traditionally, loans are made at a certain percentage above the London Inter-Bank Offered Rate (LIBOR), which is the interest rate banks charge one another on loans of Eurocurrencies. The interest rate above LIBOR, which is characterized in Fig. 9.3 as the Eurocurrency borrowing rate, depends on the credit-worthiness of the customer and must be large enough to cover expenses and build reserves against possible losses. The unique characteristics of the Eurocurrency market allow the borrowing rate usually to be less than it would be in the domestic market. Most loans are made on variable-rate terms, and the rate-fixing period is generally six months, although it could also be one or three months. Because of the variable nature of the interest rates, the maturities can extend into the future.
The LIBID is the bid rate that corresponds to the LIBOR, and the difference between the LIBOR and the LIBID is usually about one eighth of a per-centage point. The rate one earns on deposits in the Eurocurrency is usually less than the LIBID, but it is often more than can be earned in the domestic market.
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